Internal Control

The auditor is evaluating the internal control of a new client. Management has prepared its assessment of internal control and has concluded that it has some deficiencies, but no significant deficiencies and no material weaknesses. However, in reviewing the work performed by management, the auditor observes the following:

  • Sample sizes taken were never more than ten transactions, and most of the tests of operating effectiveness were based on a sample of one, performed as part of a walkthrough of a transaction.
  • Management has fired the former CFO and a new CFO has not been appointed, but management indicates it is searching for a new CFO, and it currently has depth in the accounting area.
  • The company has no formal whistleblowing function because management has an open-door policy so that anyone with a problem can take it up the line.
  • Management’s approach to monitoring internal control is to compare budget with actual expenses and investigate differences.


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In response to inquiries by the auditor, management responds that its procedures are sufficient to support its report on internal control.

The auditor’s subsequent work yields the following:

  • Many controls do not operate in the way described by management, and the procedures are not effective.
  • There is no awareness of, or adherence to, the company’s code of conduct.
  • The accounting department does not have a depth of talent; moreover, although the department can handle most transactions, it is not capable of dealing with new contracts that the firm has entered into. The response of management is, “That is why we pay you auditors the big bucks—to help us make these decisions.”

The auditor reaches a conclusion that there are material weaknesses in internal control, thus differing from management’s assessment. Management points out that every issue where there is a disagreement is a subjective issue, and there is no one position that is better than the others. Management’s position is that these are management’s financial statements, and the auditor should accommodate management’s view because there are no right answers.

a. The partner in charge of the job appears to be persuaded that the differences are indeed subjective and is proposing that an unqualified opinion on internal controls be issued. Recognize that this is a first-year client—and an important one to the office. Apply the ethical framework presented in Chapter 4 to explore the actions that should be taken by the audit manager regarding (1) whether to disagree with the partner and (2) if there is a disagreement, to what level it should be taken in the firm.

b. Given the deficiencies noted, does the information support that there is a material weakness in internal control? If yes, what are the major factors that lead you to that conclusion?

c. Assume that the engagement team makes a decision that there is a material weakness in internal controls. Write two or three paragraphs describing those weaknesses that could be included in the audit report.

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